eBay: Cautious On Marketplace

eBay recently reported Q3 results, delivering above consensus numbers - yet shares are down over 9% since the report.

The company\'s core marketplace segment has seen GMV growth decelerate and revenues stagnate.

Going forward, we believe that the company will face increased competition from specialized marketplaces.

In spite of this, the company is valued similarly to industry-leading peers - we believe investors can find better returns elsewhere.

eBay (EBAY) is one of the world's largest e-commerce marketplaces processing over $100 billion in annual gross merchandise volume. The company's achievements are nothing short of impressive.

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Just this past week, the company reported their Q3 results which came in higher than consensus estimates. Shares dipped after the release as activist investors continue to pressure the company to spin off its StubHub and Classifieds business.

Looking years down the road, we believe eBay is vulnerable in an increasingly competitive e-commerce environment. Although the company boasts a strong network effect, the rise of new specialized marketplaces has the potential to chip away at this. At a valuation in-line with better-performing peers, we believe that long-term investors can find better returns elsewhere.

When eBay first came to life in the early 1990s, the company was one of the first e-commerce marketplaces. This first-to-market advantage allowed the company to create a strong network effect. This was further helped by the subsidization of seller fees. Much like a snowball, the company grew to considerable scale and value. In 2018, eBay's share of e-commerce was larger than retail icons like Apple (AAPL), Walmart (WMT), and Costco (COST).

Since then, the company - with the help of its strong network effect - has become a significant player in the e-commerce space. With business-to-consumer and consumer-to-consumer transactions taking place, items on the eBay marketplace are widespread serving many different verticals.

Yet in recent years, we have seen the rise of many specialized marketplaces. These new specialized marketplaces have grown to significant sizes themselves, and are serving specific verticals. One example of a specialized marketplace is CarGurus (CARG) which has both B2C and C2C offerings.

These new specialized marketplaces will break up eBay's widespread marketplace by offering niche marketplaces with a much more tailored set of solutions to buyers and sellers. In the coming years, we continue to expect new entrants and believe this poses a risk to eBay's core marketplace offering.

Trailing twelve-month revenue came in at $10.9 billion in Q3, flat year-over-year. Total gross merchandise volume decreased by ~2% y/y, with marketplace GMV also declining by 2% y/y. TTM active buyers on the marketplace continued to increase steadily at 4% y/y, with transaction take rate increasing 30 bps sequentially and 50 bps y/y.

Marketplace GMV comprises ~94% of total GMV. Marketplace revenues - both transaction and MS&O - comprised nearly 80% of revenue. Going forward, we believe this segment is most vulnerable to new specialized marketplaces which can chip away at the company's network effect and adversely impact transaction volume.

StubHub saw GMV growth come in flat year-over-year. StubHub transaction take rate increased by 10 bps y/y, and 150 bps sequentially. In the recent past, activist investors have been pushing for eBay to spin off StubHub. In Q3, StubHub revenue comprised ~11% of total revenues.

Gross margins in the quarter continued to slide, reaching ~77.2%, down 50 bps y/y. On the operational side, the company spend just over 30% of their revenue on sales & marketing. In the long run, should new vertical marketplaces really take off, we wouldn't be surprised to see eBay ramping up S&M spend in an effort to retain active buyers which could pose a risk to margins.

Looking at free cash flow, the firm is quite profitable. Operating cash flow margins sit at ~38%. Given low CAPEX, the firm is able to turn up strong free cash flow margins. However, we see this as a double-edged sword - it places eBay in a vulnerable position against competitors with deep pockets. With nothing more than their network effect, we see eBay in a vulnerable state.

When comparing eBay to other marketplaces, the company's valuation is in-line with the peer median of ~3.8x EV/sales. Marketplaces like Etsy (ETSY) and CarGurus (CARG) trade at lofty multiples given their high growth rates, while industry leaders like Amazon.com (AMZN) trade at sub-4x EV/sales.

When an industry-leading company like Amazon is trading in-line with eBay, which has seen GMV growth decline y/y and faces considerable competition in the coming years, we become skeptical of the company's valuation. With this in mind, we believe long-term investors can find better returns elsewhere.

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.